Reshoring the US Economy

The term “reshoring” is coming into vogue now as the possibility exists that we may see several firms bring back their manufacturing operations to the United States as a result of rising wages in China.

Recently, I read an article in the Supply Chain Digest from June 6, 2011 titled “New Study From Boston Consulting Finds China Manufacturing Cost Advantage Over US to Disappear by 2015.” Admittedly, the fact that this article is over a year old is why it caught my interest, because now we have the happy opportunity to see if the labor cost escalation trend has actually been moving up at the predicted rate.

The article says that China’s labor costs alone will rise to 69 percent of US costs in some regions before logistics, duties, inventory, and other costs. Keep in mind that if this is the case, then there will be less incentive for US companies to contract with Chinese firms for long-term commitments unless the costs of services are guaranteed to hold steady over the life of the contract.

Factor in the fact that workers in the United States are much more productive than their Chinese counterparts and the higher productivity per hour worked begins to be quite significant in the analysis. For instance, according to the BCG report, China’s productivity was just 29 percent of that of the United States in 2010. With BCG predicting China’s productivity will rise to around 38 percent by 2015, that takes the working hour equivalency number to more than two hours of pay in China for every hour paid in the United States.

So simply speaking, even if China, with all of the anticipated work forces supplemented with robots, yields a top end productivity of 50 percent relative to the US, it means Chinese wages would have to be twice as much as they are now to erode its competitiveness. At 38 percent predicted, almost three times the current wage would be paid out to extract the same amount of work now yielded by the US.

Foxconn pays about $28 per day for a worker with at least two years on the job. Let’s boil that down to $2.80 per hour for a 10-hour day. Now we need to multiply that by three to get our real equivalency wage here in 2012. So dollar for dollar, US vs. China, for the same work, the US is covering the cost of Chinese labor at $8.40 per hour. This is before freight, duty, taxes, and other logistics. To be fair, we have to look at the carbon footprint costs that may eventually be levied against US firms for fossil fuel emissions from the various overseas transportation modes.

New analysis from the Boston Consulting Group (BCG) suggests that the move offshore to China by US companies in search of lower labor costs may slow significantly over the next few years and even reverse course, as rising wages in China will make it more costly than the US in four years, when productivity differences are factored in.

As the wage gap with China shrinks and certain US states become cheaper, we will see manufacturing responding to the fiscal pressures by bringing the work back home. Europe will not be so fortunate, and will continue to lose manufacturing to more cost-effective Chinese sources due to higher labor costs there than in the US.

BCG claims that the two biggest drivers of cost increase in China are the appreciating Yuan and higher wages. To quote directly from the article:

With Chinese wages rising at about 17% per year and the value of the Yuan continuing to increase, the gap between US and Chinese wages is narrowing rapidly. Meanwhile, flexible work rules and a host of government incentives are making many states — including Mississippi, South Carolina, and Alabama — increasingly competitive as low-cost bases for supplying the US market.

BCG predicted that labor costs in the US will only grow about 3 percent in the period from 2010 to 2015, to just over $26 per hour on average, while wages in China will increase between 15 percent and 20 percent each year.

To conclude that the United States will be more competitive than China by 2015 may seem like a stretch, but the middle class in China is expanding, bringing along with that growth an increasing demand for US-made goods. We should see more of a trade balance as we increase our exports and China cuts back on their exports to the United States due to higher labor cost factoring into their end product wholesale and retail cost. Money earned and spent in the United States will be used to build more efficient manufacturing operations with innovative robotics and cutting-edge technologies. Our productivity rates will continue to increase while China’s labor cost continues to rise, making them less competitive overall.

In the next article, I will track BCG’s prediction from 2011 to today. If we look at the vital statistics and they prove to be indicative of a strong motivation to bring manufacturing back to the US, we may see the other ancillary business functions like HR and tech support come back as well. That will mean more jobs coming back and that can only be good for our ailing economy.